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The search giant is said to have offered $1.6 billion for one of the Web's most popular social networking sites

The blogosphere is abuzz with speculation that Google (GOOG) is bidding $1.6 billion for YouTube. Neither company is discussing possible talks, as is typical with acquisition deals. But it wouldn't be surprising if Google was interested in the user-generated video sharing site. After all, YouTube is one of the Internet's most popular social networking destinations, with roughly 20 million unique visitors a month.

What online player reliant upon advertising wouldn't be interested in that kind of traffic? In fact, rumors also abound that Yahoo! (YHOO), Viacom (VIA), and even Time Warner's (TWX) AOL explored acquiring the startup, though each company declined to comment about possible past negotiations.

What's surprising is that Google, the king of do-it-yourself Web projects, would bid so aggressively to acquire a company without a proven method of making money. YouTube has been vocal about not running ads before its videos. It has been far less clear about how it will monetize its massive audience.

Todd Dagres, a general partner at Boston venture-capital firm Spark Capital, says such a bid would be a bit out of character for Google, but ultimately makes sense. "I'm a little surprised because it goes against their philosophy and personality to pay this much for an acquisition, but I think they view this as an imperative to get into user-generated video," says Dagres.

CORE COMPETITION. There are several reasons Google sees social networking as key to its continued success. For one, user-generated video sites combine two online arenas advertisers aggressively want to enter. The advertising dollars U.S. social networking sites collect is expected to grow from $280 million this year to $1.9 billion in 2010, according to estimates by research firm eMarketer. By 2009, the firm estimates that online video advertising will balloon to $1.5 billion (see BusinessWeek.com, 8/23/06, "Online Video: Tasty Takeover Targets?").

Second, though Google is clearly the dominant search player, it's still facing increased competition for its core search users from Yahoo, Microsoft's MSN (MSFT), and others (see BusinessWeek.com, 10/05/06, "A Gaggle of Google Wannabes"). Social networking sites have the added ability of generating user loyalty and increasing the barriers to switching to other Internet portals or platforms.

Despite controlling more than 51% of the search market, Google could lose some of its search share if it doesn't proactively move into the social media space, says Forrester Research's Josh Bernoff. "Google is at risk right now of someone coming up with a better search utility and luring users away," says Bernoff. "If your friends are all on MySpace, you have to be on MySpace. If your friends are all on YouTube, you have to be on YouTube. These sites have the power of human relationships, which is much more sticky than just having a good utility."

BUY RATHER THAN BUILD? To date, Google's homegrown efforts to enter the social media market have been relatively lackluster. Google's video site, for example, ranks a distant fifth in the online video space—behind Yahoo Video, News Corp.'s (NWS) MySpace, YouTube, and MSN Video, according to an August, 2006, comScore report. YouTube's market share in the video space is four times that of Google's, according to September data from Hitwise.

Paul Keung, an analyst with CIBC World Markets, says Google can't build the kind of brand recognition YouTube has in the video space. "It's hard to replicate the brand and the audience," says Keung, "and YouTube has a great network at this point." Similarly, Forrester's Bernoff says building its own site is more difficult than buying. "They could build it, but it would take a long time and, at the end of it, they would have to start trying to suck the traffic away from YouTube," says Bernoff. "This is a way to gain momentum in a space where momentum is very important."

Furthermore, there is not a very good precedent for big online companies successfully growing their own user-generated content sites from the ground up. Yahoo's social networking sites have been significantly bolstered by recent acquisitions of startups such as del.icio.us and Flickr (see BusinessWeek.com, 10/2/06, "Yahoo's Strategy: Growth by Acquisition").

PAYING A PREMIUM. Perhaps more important, Google doesn't want another online player to grab YouTube. If YouTube added its traffic to Yahoo, for example, Yahoo could not only sell lucrative, targeted ads on YouTube's sites based on its audience numbers, but it could also get that audience's related search traffic. Google has showed willingness in the past to pay a premium for such traffic and the ability to serve ads to it. In August, it paid News Corp. $900 million for access to serve ads to the MySpace crowd (see BusinessWeek.com, 8/08/06, "Google Gets Back into MySpace").

But is YouTube really worth more than $1 billion? CIBC's Keung says that, providing Google continues to attract and target advertisers as it has in the past, $1.6 billion could be a bargain. "I can come up with numbers that make it an awesome deal, but it is all in the execution," says Keung. In an Oct. 6 note to investors, Keung writes that YouTube has the potential to generate $200 million to $300 million in ad revenues in 2007 alone at the going online advertising rates of between $20-$50 for cost-per-thousand impressions. It could make even more if it finds a way to monetize the traffic with new technology, Keung notes.

However, there are problems with YouTube that make it a risky purchase. Chief among these is the copyright issue. Because YouTube does not prescreen the videos uploaded to its site, copyrighted content sits on its pages until it is removed. YouTube has taken the position that, because it removes the content as soon as it is notified, it is operating according to the rules set out by the Digital Millennium Copyright Act. Yet, it was still sued in July for copyright infringement by an independent photographer (see BusinessWeek.com, 7/27/06, "Whose Video Is it Anyway?"). Universal Music Group is also upset about its content being uploaded to YouTube and is weighing whether to file a copyright infringement lawsuit against the company (see BusinessWeek.com, 9/18/06, "Sour Musical Notes on YouTube, MySpace").

COPYRIGHT ISSUES. Google's deep pockets would make lawsuits all the more likely. "YouTube can wait until somebody screams the content is offensive, but Google would have to clean it up a bit and be sure that copyrights are not being violated," says Spark's Dagres. Otherwise, "the damage could be up to a half a million dollars per issue."

In an e-mail to BusinessWeek, billionaire tech wunderkind and Dallas Mavericks owner Mark Cuban wrote that the copyright issues made YouTube an unattractive acquisition. "I don't think an acquisition would be smart until all the copyright issues are decided," wrote Cuban. "It would be reminiscent of BMG buying Napster."

In Napster's case, lawsuits all but crushed the peer-to-peer file-sharing company. However, Google has the money and expertise to ensure the same doesn't happen with YouTube. Jason Schultz, a staff attorney with the Electronic Frontier Foundation, says YouTube is no Napster.

"A lot of people have been trying to compare YouTube to the original Napster. But they are not exactly the same," he says. "The vast majority of content on [the old] Napster was straight-up content from major record labels. What you are seeing with YouTube is that, though originally there was a lot of content taken straight from movies and television, there is still a fair, and increasing, amount of user-generated content on there. YouTube can show that there is a significant percentage of people using it for legitimate purposes," says Schultz.

Google also has the funds and knowledge to remedy YouTube's copyright issues. There is filtering technology out there that can limit the upload of known copyrighted content. Guba, for example, uses such a filter. If the technology is out there, there's little reason why Google's skilled engineers couldn't acquire or build it. Google also has experience defending itself against copyright infringement suits. The company is currently in legal battles over its image search, book search, and policy of caching Web pages, notes Schultz.

YouTube's problems aside, the true question is not whether the site is worth $1.6 billion, but whether it's worth that much to Google. When you're valued at about $128 billion, what's a billion, says Dagres. "The company has Monopoly money."